There is some good thinking among the details of the government-mandated review into local government pension schemes in England and Wales. But the big picture presents very real dangers, as the review may deflect attention from the fundamental challenge.

In essence, the report is suggesting a “cheap and cheerful” approach to managing the pensions of 4.5 million people. That is the effect of the proposed big switch from active to passive management. The focus is on cutting costs, rather than seeking more effective decision-making across the broader investment waterfront.

Greater use of passive management has its merits – but it is not an adequate response to the size of the deficit. The magnitude of the looming funding crisis in the provision of public pensions suggests that what is required is nothing short of a fundamental review of contributions or a fundamental review of benefits.

Nor does the review make any distinction between the well-governed, successful funds, which might feel they have no need of a government prescription, and those that face greater challenges.

According to the government’s numbers, reconfiguring the investment management arrangements would save £660 million, a mere 0.2% of total assets. Compare that with annual employer (that is taxpayer) contributions of £6 billion and an estimated funding deficit of in excess of £70 billion. A £660 million annual saving is not to be ignored, but it pales beside the real problem.

The really big impact on long-run returns comes not from modest savings from switching to passive management, but from decisions on asset allocation strategy and risk management. Many funds are exposed to considerable interest rate and inflation risks, which are a much bigger threat to funding status than the issues the government has chosen to address.

Nevertheless, if you dive into the details it is clear that the government is listening to the local authority industry, and is backing away from some of its worst centralising notions. Developing collective investment vehicles, for instance, as a cost-effective way to invest in alternatives, is vastly preferable to the formation of a single national investment vehicle. It is also vastly preferable to forcing funds to merge.

It has never been clear that most funds would need to group together – with the trouble of setting up collective investment vehicles and governance arrangements for multiple interests – to obtain favourable fee terms for passive management.

To my knowledge, providers will offer local authorities extremely competitive fees – even by the already low standards of passive managers – under standard contracting terms for passive management services. As a result, most, perhaps all, of the savings that could be made through more radical moves such as collective vehicles and fund mergers can be captured faster and with less complexity.

Some perspective is also needed on the approach to alternatives investment. The focus on moving away from funds of funds approaches to alternatives investing is narrow and limited. A variety of other means exist for controlling the costs of managing alternatives. The advent of “alternative beta” approaches, for example, and other ways of capturing alternative risk premiums in a cost-effective way are valid alternatives to the collectivised prescription being promoted.

It seems likely that some collective investment-based groupings will develop over time. It is to be hoped that co-operative behaviour will yield results. I think it will. But it is also to be hoped that the government does not impose a single prescription on an industry that is already, voluntarily, making significant strides in improving its act.

The solution on the table is not a silver bullet; but its selective adoption, in a voluntary environment, by those that see value, might at least provide a silver lining.

Andrew Kirton is European/Pacific investments leader at Mercer

This article originally appeared in the print edition of Financial News dated May 5, 2014